Transcript Global investment

Investment
Global Investment
Foreign Direct Investment
MNCs
Overview









When should firms undertake global investment?
What are the 2 principal types of global
investment?
What are the 2 main types of FDI?
Which do host governments prefer?
Which do firms prefer?
What is most distinctive about the pattern of global
investment between countries?
Is there such a thing as a global corporation?
What are the primary benefits for host countries
from FDI?
What are the costs?
Need to know

Understand



Principal types of global investment
Pattern of Foreign Direct Investment that occurs
between countries
Why firms undertake FDI and become
multinational in their operations rather than
simply exporting products or licensing their
know-how.
FDI Explanations


Economists assume domestic firms have a
local advantage.
FDI is profitable only if:

Industrial organization.


Overseas firms bring some kind of technological or
managerial superiority.
Cost of capital.

They obtain their financing more cheaply.
FDI Explanations
The industrial organization model
for FDI focuses on ownership
advantages:




Patents,
Trademarks,
Management techniques
Locational advantages such as
resource availability.
Key Terms




The flow of FDI refers to the amount of FDI
undertaken over a given time period
The stock of FDI refers to the total
accumulated value of foreign owned assts
at a given time
The outflows of FDI refer to the flow of FDI
out of a country
The inflows of FDI refers to the flow of FDI
into a country
Growth Environment

Reasons for recent FDI growth




Rapid economic growth in emerging markets.
Significant improvements in global transportation and
communications technology
Liberal policy changes ending capital controls and
promoting privatization and deregulation in home & host
countries
Market economies emerge in former Soviet bloc


LUK/Pepsi
Crisis?
Global Investment



2 types
Portfolio, Direct
Foreign Direct Investment




Tangible assets such as factories, capital goods, or
land.
Traditionally in manufacturing or resource extraction.
Recent shift towards services.
Patient capital
LUK/ Bolivia
Global Investment

Portfolio Investment




An investment that does not generate any
managerial voice.
Takes place primarily through financial
institutions: banks or investment funds.
Examples include bonds or equities insufficient
in magnitude to give the investor a say in
management.
Volatile, or “hot” money.
FDI (IMF Definition)

“An investment to acquire a lasting interest
in an enterprise operating in an economy
other than that of the investor, the investor’s
purpose being to have an effective voice in
the management of the enterprise.”
2 Types of FDI

Greenfield:



Acquisition:


Creation from the ground-up of an economic asset or
other productive asset. (Mercedes in Alabama)
Brownfield in Russia
Purchase by foreigners of an existing asset.
(Leucadia/Argentina)
Which do governments prefer?


Net economic value of takeovers only positive if new
owners make more productive use of existing asset
Rationale for privatization
Types of FDI


Another View
Horizontal Direct Investment



FDI in the same industry abroad as company operates at home.
DHL buys Airborne .
Vertical FDI takes two forms




Backward vertical: FDI is an investment in an industry abroad
that provides inputs for a firm’s domestic production processes
Exxon buys exploration services company.
Forward vertical: FDI occurs when an industry abroad sells the
outputs of a firm’s domestic production processes.
PDeVsa buys gas stations
Acquisitions vs. Greenfield

Most FDI is in acquisitions




Quicker to execute
Valuable strategic assets
Synergies or increased efficiency with acquired
firm
Fewer start-up risks
FDI Flows

Historically, most FDI has been directed at
the developed nations of the world as firms
based in advanced countries invested in
other developed country markets


The US has been the favorite target for FDI inflows.
Why?
FDI Flows

While developed nations still account for the
largest share of FDI inflows, FDI into some
developing nations has increased

Most recent inflows into developing nations have
been targeted at the largest emerging economies.

China, India, Brazil.
Services



More FDI in services
Services?
The shift to services is being driven by four factors




Many developed economies have shifted away from manufacturing
and toward service industries
Services are hard to trade internationally
Many countries have liberalized their regimes governing FDI in
services
The rise of Internet-based global telecommunications networks.

Has allowed some service enterprises to relocate some of their value
creation activities to different nations to take advantage of favorable
factor costs.

Call centers, accounting
FDI & Risk


Why not export? Or, license?
FDI expensive and risky compared to
exporting or licensing.



Capital costs of new facilities.
Political and country risk of different business
and social environment.
Luk Investment Committee/Colorado
Risk


Moscow/Hurdle Rate
Global operations means multiple political,
economic, legal, social, & cultural environments




Home and host country economic policies, legal &
regulatory environments.
Widely diverging economic parameters: income, age,
urbanization etc.
Business philosophy, patterns of ownership and
management training.
Social, cultural, linguistic patterns can vary
Incentives
Summary
 Why invest overseas?

Allows firms to increase their profitability
and rate of growth in ways not available to
purely domestic enterprises.
 May be required to match overseas rivals

Incentives

Firms that operate internationally are able to




Expand the market for their domestic products
Realize location economies by dispersing
individual value creation activities
Realize greater cost economies
Earn a greater return by leveraging any valuable
skills developed in foreign operations
Expanding The Market

A company can increase its growth rate by
taking goods or services developed at home
and selling them internationally




Increases sales
Allows for greater economies of scale
Returns from such a strategy are likely to be greater if
indigenous competitors in the nations a company enters
lack comparable products
P & G 1930s-1990s
Expanding the Market

Global market expansion often rests upon the core
competencies that underlie the development,
production, and marketing of goods or services
 Core competencies are skills within the firm that
competitors cannot easily match or imitate
 Toyota in auto production and logistics.
 Proctor & Gamble in consumer products.
Location Economics


Firms benefit from locating value creating
activities in optimal locations
Countries differ across a range of
dimensions.



Economic, legal, educational, cultural
Factor costs
Allows for reducing the costs of value
creation activities or enhancing product
differentiation capabilities
Global Supply Chain


Configuration of value-adding activity
Applied location economics
 The pattern or geographic arrangement of locations
where the firm carries out value-chain activities.
 Locates firm’s sourcing, manufacturing, and distribution
locations worldwide.
Global Supply Chain


Allows the firm can concentrate these
activities in countries where it can maximize
its competitive advantages.
Firms configure these activities to save
money, reduce delivery time, access factors
of production, and extract advantages
relative to competitors.
Legal Treatment


Two basic types of non-discriminatory treatment
cover foreign investment.
Derive from custom, judicial decisions, and treaty
law.



National Treatment: Treatment no less favorable
accorded by host government to its own nationals and
companies under similar circumstances.
MFN: Treatment no less favorable than that accorded
nationals and companies of 3rd countries under like
circumstances.
Investors want National Treatment. Usually get MFN at
best.
FDI More Intrusive


Portfolio investment is driven more by
differing rates of return among national
economies
FDI sector specific



Competitive advantage over local firms
Longer term, more integrative local presence.
More controversial politically
Investment Issues

MNCs




Host Countries




Protection against expropriation. Performance
requirements
Equal treatment
Transparency
Add jobs, capital, new technology from FDI
Develop and protect domestic industry
Performance requirements
NGOs

Environment, labor standards, human rights
Multinational Corporations
A company that…




Engages in foreign production through
its affiliates located in several countries,
controls the policies of its affiliates, and
implements production, marketing, and
finance strategies that transcend
national boundaries.
Aims to secure least cost production
facilities for world markets.
More than an exporter or foreign
manufacturer or licenser.
Orientation




Home-country oriented (multi-domestic)
Host-country oriented (transnational)
World oriented (global)
MNCs Agents of Globalization

Cohen: Prime agents of globalization




Distributes goods and services across national
borders
Establishes production facilities and integrates
production on a global scale.
Spreads ideas, tastes, and technology.
Still, MNCs and FDI highly concentrated and
distributed very unevenly around the world
Transnational Management

New corporate structures have emerged to
exploit new investment opportunities.




Per UN now 64,000 international companies
and 870,000 subsidiaries
60% of world trade is within MNCs.
Many have global brands, R&D, and regional
profit centers
MNCs are increasingly being managed on
regional, if not global lines.

Europe, North America, E. Asia
MNCs & Trade



Foreign production of US MNCs 4x exports by
1970.
Many US firms have more than ½ their assets
abroad and derive more than ½ their earnings
from overseas.
Intra-firm trade—transactions between
subsidiaries of the same firm. Huge proportion of
world trade



1/3 US exports
2/5 US imports
½ all trade between US and Japan.
Who is “us”?

How do you determine the “home country” of a
multinational?



Toyota is headquartered in Japan, but directly employs
34,000 North Americans, not to mention 150,000
supplier and dealer employees and has contributed
nearly $200 million to US charities since 1991
GlaxoSmithkline, the large pharmaceutical, is
headquartered in the UK, but operations are based out
of the US. R&D takes place at 20 sites in eight
countries, including Spain.
What companies should a state support?

Who is a US MNC? Who is a UK MNC?
Where is Home?

A company tends to locate its highest valueadded operations in the country it considers
“home.”



Research and Development
Manufacturing of the most sensitive
components
But today’s MNCs have extensive R&D facilities
abroad.
Is Toyota “us”?
Resource Transfer Effects

FDI can make a positive contribution to
a host economy by supplying

Capital

Technology

Management

Jobs
Host Country Benefits of FDI

Host country benefits from initial capital
inflow when MNC establishes business



Host country records current account debit on
repatriated earnings of MNC
Host country benefits if FDI substitutes for
imports of goods and services
Host country benefits when MNC uses its
foreign subsidiary to export to other
countries
Host Country Benefits

Greenfield investments increases the amount of
competition, which can:




Drive down prices
Increase the economic welfare of consumers
Increased competition tends to stimulate capital
investments
Long-term results may include



Increased productivity growth
Product and process innovations
Greater economic growth
Host Country Costs


Adverse effects on competition. Local firms
lose out.
Adverse effects on the balance of payments



After the initial capital inflow there is normally a
subsequent outflow of earnings
Foreign subsidiaries could import a substantial number
of inputs
National sovereignty and autonomy

Some host governments worry that FDI is accompanied
by some loss of economic independence resulting in the
host country’s economy being controlled by a foreign
corporation
MNCs and Home Countries

Support of State in efforts
abroad





Government backed risk
insurance. (OPIC)
Government loans. (Ex-Im
Bank)
Eliminate double taxation.
Political persuasion to relax
restrictions on inbound FDI.
(Treasury)
Support of enterprise needs
in multinational negotiations


Multilateral Agreement on
Investment, e.g.
US-China WTO agreement

State efforts to limit unfair
competition at home


Limit capital outflows for
foreign investors.
Non-tariff barriers:



Anti-dumping/
Countervailing duty laws
Subsidies (EU’s CAP and
US Farm Bill, e.g.)
Regulatory systems to avoid
competition

Japan’s Large Store Law
prevented Toys R Us or
other large stores from
investing
MNCs and Host Countries

State promotion of inward
investment

Offer incentives






State constraints on inward
investment

Tax concessions
Low-interest loans
Grant/subsidies
Attempt to attract investment
away from other countries
States and regions within
countries
Create strong infrastructure and
economic environment


Ex. Costa Rica’s governmentfostered infrastructure and
economic strength led Intel to
recently build a 5,000 employee
chip manufacturing plant.
Ownership restraints.



Performance requirements





Excluded from specific areas
 National security.
 Competition.
Restrictions on ownership %.
Local content.
Technology transfer.
Local participation in
management
Politically motivated efforts to
legislate labor conditions and
environmental requirements
Territorial tax jurisdictions
Pragmatic Nationalists




Most nations are pragmatic.
Generally, resource transfers benefit and
strengthen the host country
All countries impose some restrictions on
FDI
Allow FDI if benefits outweigh costs


Block FDI that harms indigenous industry
Court FDI that is in national interest


Tax breaks
Subsidies